IFR: Isn’t it also a question of discipline at the borrower end to make sure the funding mix is right? Thomas, is that discipline in balance?
Thomas Haas, BayernLB: As a loan banker, as a relationship bank, you need to compete with prices and structures across the market. That is a challenge because a corporate treasurer will have met a Schuldschein guy who has told them: “look, my offer is better than that one; figure out what you want to do”. So first of all there is competition.
I would not agree that Schuldschein buyers don’t know what they’re doing. In the past couple of years, we have seen some restructurings where the market has experienced some difficulties. If you attend events around this product there are a lot of lawyers really keen on potential restructurings because they create a lot of work.
To Reinhard’s point, I doubt that relationship banks will be that keen to jump into difficult situations. If you have a small proportion of Schuldschein, that might work but these instruments are becoming larger and larger and at difficult times banks won’t necessarily be willing to pay out Schuldschein investors at 100%. So there will be a hit, there will be a restructuring that depends on the specific market situation and on the size of the Schuldschein.
That could be an issue going forward but I think people are experienced around these situations; it’s on their radar. You could also ask whether a regional, local or small bank investing outside of its territory represents some kind of risk mitigation.
Sandro Pittalis, NordLB:
It’s a question of quality. I would agree with Reinhard that there are a couple of very aggressive competitors in the market pushing some companies that are not suitable for Schuldschein. We do run the risk of diluting the market.
We observed similar developments with the SME corporate bond (Mittelstandsanleihen) market, which saw huge growth in 2010 and 2011 but experienced a high number of defaults due to both a mismatch of quality and a mismatch of good advice from banks and lawyers. Speaking from the credit appraisal and risk side, SSD is still an investment-grade product which might be suitable for some crossover companies but we need to be careful and make sure we’re not being driven by fees to push companies into the Schuldschein market.
Enrico Miketta, LBBW: I couldn’t agree more. You mentioned advisory, and that is an important issue. You asked earlier about the perspective of SME CFOs and treasurers. On one hand, there are very attractive financing opportunities out there but on the other hand it has become more complex than before because corporates now have to decide which route they want to go.
They need advice about how important optimising their tenor profile is and how important investor diversification is. With regard to SMEs, we have different types of companies. There are listed SMEs; there are SMEs experienced in Schuldschein or bonds; and we have 100% privately-owned companies. The latter category captures the majority of German SMEs. The shareholders of these companies don’t necessarily want to issue an instrument to 30 or 40 investors.
They are willing to pay a premium for a syndicated loan because five or six core banks can fulfil their financing needs. The task of banks is to better advise our clients. There is a range of products; they have advantages and disadvantages and corporates have to decide which one fits their strategy or the strategy of their shareholders.
It’s becoming more and more important to look at how different products fit together. We have the majority lender concept on the syndicated loan, which makes that product very stable. We have another concept on the Schuldschein, and that’s the main reason why it is broadly an investment-grade product or in some cases crossover. But you have to be very careful with cross-default and cross-acceleration clauses and you also have to be very careful with regards to financial covenants because if things go bad, you have to be able to handle the situation.
Martijn Kamps, ING: Because of the cross-acceleration elements in there, if financial covenants are triggered, the Schuldschein may hit the wall but it may not cause the whole debt structure or financing mix to collapse. This goes back to the earlier arguments about how we distribute this product: the majority of Schuldschein investors are still professionals.
They should be able to judge what they’re getting into and they should have a view on what type of rating category they are looking at, and how a cross-acceleration versus a default works, even if there are financial covenants. SSD investors are still at a distance compared to a relationship bank, and they may have an information disadvantage but the majority of the investor base is able to make an educated choice about whether to invest in a Schuldschein product.
IFR: We’ve talked about investment grade and crossover, I wanted to talk about the funding optionality available to pure sub-investment grade German SMEs.
Enrico Miketta, LBBW: As long as they are not in restructuring mode, funding sources and opportunities for this segment are very good. They will have to pay a premium, they may have to put up collateral and we are definitely talking about financial covenants. But the bank market is very open. And you have products such as factoring, securitisation or leasing. There is funding access but it has a price premium and a structure premium.
Reinhard Haas, Commerzbank: The spectrum of products is narrower in sub-investment grade, especially on the fixed-income side. The liquidity of the markets that are open to these borrowers is definitely not the same as for investment grade. There were attempts in prior years to replace a high-yield product with a smallish private version but that generally hasn’t worked out. We don’t have a stable market for sub-investment grade bonds away from rated high-yield.
Pure sub-investment grade is dominated by bank lending and institutional investors. There are unitranche facilities in the sub-investment grade space but they’re geared towards institutional investors. But it’s bespoke and I haven’t seen that many deals done in Europe; it’s more of a US phenomenon so far but it is something which I think is here to stay.
Johannes Hack, DZ Bank: Even in that segment there’s a price mismatch. If you look at what you’d get on a unitranche, which is going to be in the 600bp-700bp area, and what you get on something that is not completely distressed on the corporate side that will maybe be paying 300bp-350bp, they’re basically getting the same amount of leverage for a much lower price.
It proves that there is a big need to go down the credit curve but once the cycle turns, it’s not going to be all that easy.
Thomas Haas, BayernLB: The most likely instrument for this segment is still the syndicated loan because you’re dealing with a small group of banks that know the corporate story, know the strategy and know the driver behind the low rating and what the problems are: is it just a dip in numbers that will be gone in a couple of quarters, is it an acquisition, is it management strategy?
Institutional investors need to have a story as well; they will want to take some economics out of it. We have a number of transactions in our pipeline in the deep sub-investment grade area with very small volumes but we have plenty of investors out there seeking these kinds of investment. You also have plenty of banks that have weak ratings which simply cannot afford to do investment-grade deals.
Matthias Hellstern, Moody’s: The trend to disintermediation at least for smaller companies has stopped to some extent. This is probably driven by the huge liquidity in the market and the need for banks to invest. And there are still so many banks in the German market; it’s very competitive.
There is one option that has actually more or less fallen away, which is a pity, but it is due to the fact that it’s currently not required because of the liquidity in the bank markets, and because it failed in the way it was managed. And that is the segment for listed bonds for small and medium-sized companies.
This was a market where certain intermediaries tried to make fees out of something that was not managed very well and no-one stopped them. That has closed the bond market as an alternative financing source for smaller companies for the time being.
But it’s probably something one should think about reviving because there might be times when accessing the banking market gets more difficult because of increasing regulation or less competition. It would be good for smaller companies to at least have this option available in order to achieve larger diversification of funding sources, with less reliance on the bank market.
Reinhard Haas, Commerzbank: It comes back to what Thomas said earlier: for that group of corporates, the loan format where you have majority votes on documentation, if the economic performance is not what was planned is not possible in the fixed-income product. It’s just not designed for that whereas the loan product does address that and differently from the real high-yield bond world where the companies that are issuing are of a different magnitude. That doesn’t work so well in SME.
IFR: How would you revive it in such a way that it can once again be a viable source of financing for small companies?
Sandro Pittalis, NordLB: Reviving BondM is very ambitious. As I mentioned before, first of all it’s a question of quality. In the past we observed instances where the size of a corporate bond was clearly not in proportion to an issuer’s turnover. As regards financial covenants, advisors made mistakes not tailoring properly to meet the particular needs of the issuer. If you check the prospectuses, terms and conditions seemed to be cut and pasted from other documents; I even saw the name of another issuer in one company’s terms and conditions!
A corporate bond market could work but it’s a question of quality, a question about regulation and a question about pushing suitable issuers to consider the corporate bond market.
Martijn Kamps, ING: Everybody is aware of the BondM history so I doubt there are a lot of issuers around who’ll say “let’s try this again, let me be the example”.
Enrico Miketta, LBBW: There was also a question of the kinds of investors [drawn to this product]. Even if there was a high-quality external rating, if you look at average volumes they were in the €30m-€50m area.
Thomas Haas, BayernLB: It’s completely illiquid; that’s my point. Would a conservative investor buy into a €50m high-yield SME bond? I doubt it.
Johannes Hack, DZ Bank: That was the problem, it was a retail product and it shows that you shouldn’t be selling that kind of retail product to people who are basically going on the basis of the coupon.
Sandro Pittalis, NordLB: There was a very interesting Mittelstandsanleihe issued by Karlsberg. Retail investors said: “Oh wow, it’s a very popular and very famous brand”. But it wasn’t the [Danish multinational] Carlsberg but the German Karlsberg Brauerei. Though that issue has been performing quite well, my point is the German corporate bond product was made for retail investors and it’s very important that they have an adequate level of information in order to make differentiated investment decisions.
In this context, it’s not easy for retail investors to get core information about a corporate bond issue in a prospectus comprising 200-300 pages even if the Prospectus Directive has been updated to include a summary.
Reinhard Haas, Commerzbank: To produce the same standards you have for high-yield bonds would be too costly. This is why the bond product can’t fly in this segment.
Thomas Haas, BayernLB: You have one driver and that is the market price. If you were to have a market price on a Schuldschein – to come back to the bubble discussion again – that would be very interesting because once you have a market price which goes significantly below 100 you have an issue and a potential domino effect in the market.
IFR: Direct lending funds have raised tens of billions of euros in new funds in the past 18 months or so targeting European mid-market corporates. How do you see the emergence of these players? Who are they targeting on the origination side? Do you see them as competitors or are they complementary?
Reinhard Haas, Commerzbank: We see them as marginal so far but their intention is very clear: there is not enough paper in the fixed-income market for these funds so they’re looking at other product areas and funded loans are eligible. If you ask what they are looking for, it’s funded debt.
The thing is, a large portion of the corporate market is unfunded; it’s in the form of revolving credit and those are not eligible. Plus the funded portions may be bridges that are taken out by fixed-income products. There is not much paper available for them in the SME space because you don’t have the bond products that could refinance over time.
The returns these funds need to generate can be achieved in LBO structures but they’re much harder to achieve in corporate structures because that’s usually relationship-bound, and pricing, as we all know, is not as high as in LBOs even if the risks are comparable. So it leaves these funds without any bread to eat in the loan market, especially in the SME segment. That’s why they remain marginal at this point in time. It’s not that they don’t have the potential to invest but it’s that the kind of paper they’re looking for and the returns they’re seeking are not available.
Enrico Miketta, LBBW: I agree, they are marginal. There should be an investment opportunity with regards to special capex; and SMEs could benefit from longer tenors but funded money, which core banks don’t want in the smaller SME space, is rare. Maybe we’ll get to a situation where there is less competition and less regulation in the German bank market although I doubt if we will see that within the next 10 years.
Of course they’re professional investors. Most of them come from the private equity area so they definitely know what they’re doing. But there’s a difference between a Double B minus-area LBO loan with five or six times leverage where you definitely know where the leverage is coming from and lending to a smaller SME, where, as Thomas said earlier, the difference is as a core bank you have probably known the company, the management and the shareholders for years.
To speed up your knowledge and get a good feeling and sentiment to invest in that kind of SME is tough. Maybe they have to go down the credit curve, as Johannes said earlier, but so far I don’t see that many deals.
Johannes Hack, DZ Bank: We need to be careful because in leveraged lending they’ve made a big impact, and that’s been because the product has been extremely good to the companies. Funds are large, you only deal with one guy, and they’re able to be extremely flexible. What’s holding them back right now is their yield requirement.
The moment they lower their yield requirement to a level where they can compete with a difficult crossover corporate, bang will go that difficult crossover corporate for us banks. I tend to agree with that core relationship element but the moment the borrower is able to get his funding from this new guy in town, he’s more than happy to take it.
Reinhard Haas, Commerzbank: The reason the funds have been able to raise so much money is the promise of the returns they can generate is outstripping what the market can offer today.
Johannes Hack, DZ Bank: But that keeps going down and everybody, even their investors, knows that if everything decreases you decrease along with it.
Thomas Haas, BayernLB: The funds have targets of 5%, 8%, 10%, 12%. As long as their yield expectations are above the traditional banking business model, they’ll be complementary to our product. It’s good for us to have these investors in place because banks are not in a position to keep that kind of risk on their books. But what Johannes is saying is right: those yield expectations can be squeezed going forward and they will then compete with the bank lending model.
Martijn Kamps, ING: Someone said that relationship banks always know the client, the history and what’s going on. If you compare these types of funds and where they invest, they need to do a lot of due diligence including financial covenant and financial discipline monitoring, which was maybe sponsor-driven in the past but to a lesser extent also available at family-owned SMEs.
Thomas Haas, BayernLB: If you have a huge CLO or huge fund in place they don’t rely just on an information package. They have huge resources and carry out their own very precise due diligence so they don’t even need a bank for that. And they invest in multimillion size. These guys are declining nine deals out of 10. They can’t afford to waste money on an investment that turns bad.
Reinhard Haas, Commerzbank: Banks not only know the client but they have a different angle on the client. It’s not just about lending, it’s usually about a relationship that includes ancillary businesses in different areas. The fund will never have that so the return requirements of a fund intrinsically can’t be the same as those of a relationship bank because there is no side business available for them. The funds’ credit-appraisal process might be very sophisticated but it’s too top-heavy to compete with that of the banks which live with their clients on a daily basis. They do have a role to play but I think it will remain a niche.
Matthias Hellstern, Moody’s: It’s a development that needs to be watched carefully. At the moment it’s not big enough to attract too much attention but it’s something we need to follow closely and we need to monitor how it evolves. It may be small at the moment but it seems to work in some instances as a funding alternative.
IFR: Where are we headed on loan pricing in Germany, particularly on the SME side? And how strong is the pull from other market segments?
Reinhard Haas, Commerzbank: We haven’t seen further declines in pricing as strongly as we’ve seen in prior years. What we do see increasingly is a pricing differential in banks’ funding costs in other currencies, such as the dollar. You can see that in some of the large-scale acquisition financings that have been coming to the market over the last few months. In cases where the US dollar was needed, the rates and margins that were offered reflected that pricing differential. We last saw that maybe in 2012 but that’s being reintroduced today.
Thomas Haas, BayernLB: SMEs like to have flexibility in their facilities and currencies will continue to be a cost driver for the banks going forward, given the increasing volatility in the market.
On the other hand, as I mentioned earlier, we are competing with other markets like the Schuldschein market where we still see pricing going down and that is leading to a shift from syndicated loans to Schuldschein where some borrowers have been able to get better results and tighter pricing.
Reinhard Haas, Commerzbank: But that would be limited to funded debt, which is only a fraction of the market.
Thomas Haas, BayernLB: Right. They will keep their syndicated loans but it will be undrawn and that will not pay out for the bank in terms of economics.
Martijn Kamps, ING: If you look at upside for clients in margin reduction via early refis, it’s not there so in that sense there’s not a lot of further pressure on margins. I agree with Reinhard in respect of optional currencies although in 2012 we saw undrawn optionality being priced in. Now you’re seeing it so far only in drawn portions. The other price element is an indirect price element: the Euribor floors that we seem to be discussing more and more in this context.
Johannes Hack, DZ Bank: Competition from other markets plays in very directly. We have a situation right now where we have a borrower who used to be funded via a syndicated loan with a drawn element. People have picked up on that and have gone round and told him “we can do the funded debt at a much cheaper price”, to which we can either say goodbye or we can try and react, and that obviously pushes us down another notch on pricing.
I agree that overall pricing in the undrawn market has basically stabilised, which isn’t saying a lot because there wasn’t much further it could go. In drawn money, certainly when we look at our portfolio, my view is that a lot has been replaced by bonds and Schuldschein. In pricing terms, a lot of that isn’t even relevant anymore because we simply don’t get to pitch; it’s the Schuldschein guys who get to pitch on how that money is priced.
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|Syndicated Loans Bookrunners – all German Borrowers (Jan 1 to Sept 30 2016)|
|Pro-rated Volume €bn||No of Deals||Mkt Share (%)|
|9||Bank of America Merrill Lynch||4.73||4||4.42|
|13||Sumitomo Mitsui Financial Group||4.06||1||3.80|
|14||Mizuho Financial Group||4.06||1||3.80|
|Source: Thomson Reuters|